Understanding Bitcoin Cryptography, engineering, and economics PEDRO FRANCO This edition first published 2015 © 2015 Pedro Franco Registered office John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom For details of our global editorial offices, for customer services and for information about how to apply for permission to reuse the copyright material in this book please see our website at www wiley.com All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Designations used by companies to distinguish their products are often claimed as trademarks All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners Neither the publisher nor the author are associated with any product or vendor mentioned in this book. The material contained in this book is not related to any work the author has performed for any present or past employer.  Opinions expressed in the book are solely those of the author and not express the views of the author’s current or past employers Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose It is sold on the understanding that neither the publisher nor the author are engaged in rendering professional services and neither the publisher nor the author shall be liable for damages arising herefrom If professional advice or other expert assistance is required, the services of a competent professional should be sought A catalog record for this book is available from the Library of Congress A catalogue record for this book is available from the British Library ISBN 9781119019169 (hardback/paperback) ISBN 9781119019145 (ebk) ISBN 9781119019152 (ebk) ISBN 9781119019138 (ebk) Cover design: Wiley Cover image: © Shutterstock/Lightboxx Set in 10 pt Times New Roman by Sparks – www.sparkspublishing.com Printed in Great Britain by TJ International Ltd, Padstow, Cornwall, UK Dedicated to Alvaro, Rafael, Luis, and Nayra Contents About the Author xi Acknowledgments xiii Foreword xv Prologue xvii Preface xix PART ONE: INTRODUCTION AND ECONOMICS CHAPTER Foundations 1.1 1.2 1.3 1.4 Decentralized Open Source Public Asset Ledger It’s Not Only the Currency, It’s the Technology CHAPTER Technology (Introduction) 2.1 2.2 2.3 2.4 2.5 Centralized Database Addresses, Transactions Distributed Database, the Blockchain Wallets The Different Meanings of Bitcoin CHAPTER Economics 3.1 3.2 Medium of Exchange 3.1.1 Pros 3.1.2 Cons Store of Value 11 11 13 15 17 18 21 22 25 26 27 v vi Contents 3.3 3.4 3.5 3.6 3.7 3.2.1 Bitcoin as Investment 3.2.2 Pros 3.2.3 Cons Unit of Account Deflation Volatility Effect on the Financial Industry and Monetary Policy Regulation CHAPTER Business Applications 4.1 4.2 4.3 4.4 4.5 4.6 4.7 Money Transfer Exchanges Payment Processors Web Wallets Multisignature Escrow Services Mining ATMs 29 30 31 32 32 33 35 37 39 39 40 43 43 45 46 48 PART TWO: BITCOIN TECHNOLOGY 49 CHAPTER Public Key Cryptography 51 5.1 5.2 5.3 5.4 5.5 5.6 Public Key Encryption Digital Signatures RSA Elliptic Curve Cryptography 5.4.1 Elliptic Curve Summary 5.4.2 Elliptic Curve Theory Other Cryptographic Primitives 5.5.1 Blind Signatures 5.5.2 Shamir Secret Sharing Bitcoin Addresses 53 56 59 62 63 64 71 71 72 73 CHAPTER Transactions 77 6.1 6.2 6.3 6.4 6.5 6.6 6.7 80 82 84 85 86 89 92 Transaction Scripts Pay-to-address and Pay-to-public-key Transactions Multisignature (m-of-n) Transactions Other Transaction Types Transaction Signature Pay-to-script-hash (P2SH) Standard Transactions vii Contents CHAPTER The Blockchain 7.1 7.2 7.3 7.4 7.5 7.6 7.7 Hash Functions Time-stamp Proof-of-work The Blockchain Double-spend and Other Attacks 7.5.1 Race Attack 7.5.2 Finney Attack 7.5.3 Transaction Spamming Merkle Trees 7.6.1 Transaction Malleability Scalability CHAPTER Wallets 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 95 99 101 105 113 115 116 116 117 119 120 123 Symmetric-key Cryptography Offline Wallets 8.2.1 External Storage Media 8.2.2 Paper Wallets 8.2.3 Offline Devices 8.2.4 Hardware Wallets Web Wallets Brain Wallets Deterministic Wallets 8.5.1 Message Authentication Code (MAC) 8.5.2 Hierarchical Deterministic Wallets Multisignature Wallets Vanity addresses Simplified Payment Verification (SPV) The “Payment Protocol” (BIP 70) CHAPTER Mining 9.1 9.2 9.3 9.4 95 125 126 127 127 129 130 131 132 132 134 135 136 137 139 141 143 Mining Technology Pooled Mining Transaction Fees Selfish Mining 146 149 154 156 PART THREE: THE CRYPTOCURRENCIES LANDSCAPE 159 CHAPTER 10 The Origins Of Bitcoin 161 10.1 David Chaum’s Ecash 162 viii Contents 10.2 10.3 10.4 10.5 10.6 Adam Back’s Hashcash Nick Szabo’s bit gold and Wei Dai’s b-money Sander and Ta-Shma’s Auditable, Anonymous Electronic Cash Hal Finney’s RPOW Satoshi Nakamoto CHAPTER 11 Alt(ernative) Coins 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 Litecoin PeerCoin Namecoin Auroracoin Primecoin Dogecoin Freicoin Other Alt-coins The Case For/Against Alt-coins CHAPTER 12 Contracts (the Internet of Money or Cryptocurrencies 2.0) 12.1 12.2 12.3 12.4 12.5 Digital Assets Smart Property Micropayments Autonomous Agents Other Applications 12.5.1 Crowd-funding 12.5.2 External State Contract 12.5.3 Contract for Differences 12.5.4 Distributed Exchange 12.5.5 Deposits 12.5.6 Saving Addresses 12.6 Inserting Data into the Blockchain 12.7 Meta-coins 12.7.1 Colored Coins 12.7.2 Counterparty 12.7.3 Ethereum 12.7.4 Mastercoin 12.7.5 Nxt 12.7.6 Ripple CHAPTER 13 The Privacy Battle 13.1 Network Analysis 13.2 Laundry Services 163 164 165 167 168 171 172 173 174 175 175 176 177 177 178 183 183 185 186 187 189 189 190 190 191 191 192 192 194 196 197 199 202 203 204 209 209 212 ... Understanding Bitcoin Cryptography, engineering, and economics PEDRO FRANCO This edition first published 2015 © 2015 Pedro Franco Registered office John Wiley & Sons Ltd, The... Guide (Bitcoin Foundation, 2014b) maintained by the Bitcoin Foundation, and the forthcoming book by Andreas Antonopoulos (Antonopoulos, 2014) O xix xx Preface The third part completes the cryptocurrencies. .. Designs and Patents Act 1988, without the prior permission of the publisher Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard